Optimistic Economics

Reason and expectations have a peculiar connection. It would seem that expectations emanate from reasonable assumptions or logical discourse amongst the public. Facts are juxtaposed with their probabilities and resource capacities, and then expectations are formed. However, the opposite happens. Popular reason derives from the people’s expectations. People find a way to justify what they expect. But how are their expectations formed? 

In the former half of 2020, when some parts of the world, including India, were experiencing the lethal first wave of COVID-19, predictions of economic recovery were more or less inclined towards a swoosh-shaped recovery. It is a layman’s way to state that an economy would first experience a sharp plunge, a slow rebound and an even slower recovery in the long term. There is a major role of expectations in the economy after this. But before that, it is important to know the expectations. People thought a V-shaped economic recovery was too optimistic. So, they discounted their optimism a little to come down to the level of reality. They shaped their predictions to expect a recovery only a little slower compared to the V-shaped, which boiled their expectations down to a U-shaped recovery. 

After the first wave of COVID-19 in 2020, the world still suffered from optimism bias because they had not yet felt the shock of the second wave. Financial analysts across the world predicted a K-shaped recovery, which stands to mean that after an economy crashes, some sectors not only recover but scale up to more than pre-recession levels, and some sectors plummet even below the pre-recession levels. This happens because there was an anticipation of an approaching second wave in the world. It made the majority of the population increase its acceptance of the virtual means of entertainment, education, pharmacy, and shopping etc. 

This culminated in thriving ed-tech, internet pharmacy, over the top (OTT) platforms and e-commerce businesses. Taking the complete picture into account, this is resources reallocation in play: schools and coaching centres to ed-tech, local chemist shops to internet pharmacies, cable TVs and cinemas to OTT platforms and from local stores and malls to e-commerce. Hence, just the expectation of a second wave brought about such a drastic change not only in the GDP increase from -24% in the first quarter of 2020-21 to 1.64% in the fourth quarter of 2020-21 but also in the composition of GDP due to the increased contribution of some sectors and decreasing contribution of others. 

A noteworthy observation in this interplay of people’s expectations and economic outcomes is that you would never find L-shaped, W-shaped or Z-shaped recoveries in these predictions, however hard you hunt. In case you are wondering if it is because of the low probability of these recovery shapes, then let me tell you it is not so. 

The Great Depression of the 1930’s is a testament to the reality of L-shaped economic recoveries when the economy experiences a sudden crash followed by stagnation in GDP and persistent unemployment over a long period. L-shape signifies the most horrendous recovery prospects because it essentially means no recovery at all for a considerable period. It stands for lost incomes and production. It is a nightmare, to say the least. Even India in the 1960’s and 1970’s lost a major portion of its production owing to wars with hostile neighbours and global oil price shocks. Japan experienced the same in 1989 and the following decade, which is often called the Lost Decade for Japan. 

In the pre-2008 years as well, people, as well as the governments, failed to acknowledge any possibility of an economic collapse even in the face of public debates and discussions about the approaching collapse of the housing bubble in the United States and the consequent financial crisis. People’s optimistic expectations led them to invest more and more in the housing market to expand it so much that when the bubble burst, not just the US but the whole world felt the economic shock. 

Even today, when the debate about a post-COVID economic recovery is piping hot across the world, there are fewer economists and even fewer people talking about L or W or Z shaped recoveries even though a W or Z shaped recovery seems almost logical. A W-shaped recovery is when an economic recession is followed by a recovery attempt, unfortunately leading to another economic crash followed by a steady recovery. The incoming nature of the second wave of COVID-19 wave in 2020 should have warranted predictions of a W-shaped recovery, logically speaking. However, even in the survey of financial analysts across the world, only 11% thought that a W-shaped recovery would be imminent. Even a Z-shaped recovery that symbolises an economy that first experiences a sudden crash, recovery followed by another recession would seem likely. But these ideas were rarely found in post-COVID expectations and predictions. 

Needless to say, there is a major tilt towards optimism when people talk about economic recovery. The idea of economic recovery is covertly hazy in people’s minds. It is unnecessarily associated with utopian optimism. In economics, they call it pro-growth expectations. 

In the case of India, the first and second waves of COVID-19 blatantly exposed the ill state of education and health infrastructure in the country, depriving millions of poor children of a year or more of learning and giving hundreds of people an ignominious death of oxygen scarcity. Millions of workers migrating across states on foot lay bare the callous anomalies of the informal sector and urban economy based on casual labour. 

Every time a crisis happens, it does well to expose the loopholes of the economic system. In the face of such shocks, how the governments and the people respond determines how the economy responds. As discussed, V, U and swoosh-shaped recoveries lie at the heart of most macroeconomic predictions. This optimism is reflected in the stock market bubble. With the Government of India’s numerous lines of credit and welfare schemes flowing like water to stimulate the economy, investor sentiment and consumer demand are positive as well. Whether this is a bubble that will burst in the following three to four years or would it be accompanied by correction mechanisms to culminate in long-term growth will largely depend on the actions of financial institutions and governments. Simply put, for all optimists, a V is out of reach now, and a U or swoosh is some reforms away!


Priyal Batheja

Academically pursuing Economics from Shri Ram College of Commerce and Mentally pursuing a balance between my sky-high spirits and rock bottom blues!

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